THE ASPA JOURNAL Jan–Feb 2004

Vol 34, No 1

Dynamics of a Deal:
Considerations When Buying or Selling a Pension
Service Business
by Elliot D. Raff, APM

IN RECENT YEARS, CONSOLIDATION HAS RESHAPED THE PENSION SERVICES INDUSTRY. SMALL LOCAL FIRMS WITH LIMITED
RESOURCES AND DWINDLING PROFITS ARE COMBINING WITH OTHER FIRMS TO OFFER NEW SERVICES AND CAPTURE NEW
REVENUES. REGIONAL INSTITUTIONS ARE CREATING FULL SERVICE FINANCIAL SERVICE SUBSIDIARIES BY ACQUIRING LOCAL
FIRMS, AND NEW NATIONAL FIRMS HAVE EMERGED BASED ON A STRATEGY OF SERIAL ACQUISITIONS. THROUGHOUT THE
INDUSTRY, OWNERS ARE SEEKING EXIT STRATEGIES AS THEY CONTEMPLATE THEIR OWN RETIREMENT. THERE ARE MANY WAYS TO
STRUCTURE A TRANSACTION, EACH WITH DIFFERENT ADVANTAGES AND DISADVANTAGES TO THE BUYER AND SELLER. SETTLING
ON THE MOST APPROPRIATE STRUCTURE REQUIRES AN UNDERSTANDING OF THE TAX AND OTHER LEGAL CONSEQUENCES, AN
OWNER’S GOALS, AND THE PRACTICAL CHALLENGES FACING THE BUSINESS, WHERE RELATIONSHIPS ARE CRITICAL AND THE
CALENDAR UNFORGIVING. THIS ARTICLE DISCUSSES THE REASONS FOR BUYING OR SELLING A PENSION PRACTICE, HIGHLIGHTS
THE DIFFERENT LEGAL STRUCTURES THAT CAN BE USED, AND DISCUSSES SOME OF THE MOST IMPORTANT PRACTICAL ISSUES
THAT MUST BE ADDRESSED FOR A TRANSACTION TO SUCCEED.

LETTERS OF INTENT AND CONFIDENTIALITY
AGREEMENTS
Whether buying or selling, early on, a company may
engage a business broker or other agent to help find
an interested party, arrange financing, and negotiate
the terms of the transaction. When a prospective
buyer/seller has been identified and the basic terms
of a deal have been agreed upon, the parties will
typically be asked to sign a letter of intent, often
written by the broker, describing the general terms of
the transaction in easily understood language. Banks
provide commitment letters describing the terms of
their financing.
While a party may view a letter of intent as simply
a checklist to confirm that everyone is “on the
same page” before proceeding to incur the expense
of engaging in due diligence and drafting formal
contracts, parties are often surprised to discover that
they are contractually bound by the letter of intent.
Preliminary agreements, which may seem innocuous,
can nevertheless have significant and binding legal
consequences, making it difficult and/or costly to
change agreed upon terms (or back out of a deal).
Equally important, the parties should enter into a
confidentiality agreement. Key terms to consider
carefully include what is covered as confidential
information, its return in the event the deal does not
close, and legal remedies for violation (immediate
injunction). The agreement should also include a
process for handling requests by third parties for
confidential information (e.g., providing advance
notice of the request, allowing the other party to object
to disclosure, etc.) so the party whose information is at
risk can take steps to prevent disclosure. Although it
may be impossible to totally eliminate concerns about
disclosure, a well-drafted confidentiality agreement
can go a long way in protecting a seller from improper
disclosure.
WHY BUY OR SELL A PENSION SERVICE BUSINESS?
WHY BUY?
There are many reasons for buying a pension service
business:
Roll Up for Eventual Sale: An owner may desire to
acquire other firms as the first phase of his/her own
eventual exit strategy. Having greater market share
may attract the interest of a larger institution that m
Leverage Buying Power: Having greater market
share may allow a firm to obtain better pricing and
servicing from other institutions. For example, an
administration firm with hundreds of clients all in
the same insurance company product will receive
the most favorable pricing available and the highest
level of service.

Reprinted from the Jan–Feb 2004 issue of The ASPA Journal newsletter.
The American Society of Pension Actuaries (ASPA) is an organization of atuaries, consutants,
administrators, and other benefits professionals. For more infromation about ASPA, call
(703)516-9300 or visit www.aspa.org.
 Enter New Markets: Rather than incur the cost and
risk of entering a new locale by renting new office
space, hiring new staff, and competing with existing
firms, buying an existing local firm may be more
attractive—the firm has clients, employees, a reputa-
tion, and a financial history that can be evaluated.
Offer New Services/Capture New Revenue: Again,
rather than incur the cost of building the infrastruc-
ture needed to provide additional services, buying
an existing business that specializes in that service
may be much more attractive. For example, consider
deals where banks with financial planning subsidiaries
entered into the retirement plan consulting and ad-
ministration market by acquiring established regional
pension consulting/administration firms.
Of course, a transaction can provide a combination
of these goals. For example, buying a firm that
provides investment advisory brokerage and admin-
istration/recordkeeping services can provide a
plan administration firm with entrance into a new
business (investment advice), added market share,
and buying power.
WHY SELL?
The two most common reasons for selling are the
desire of the business owner to exit the business and to
remain competitive in an increasingly tight market.
Exit Strategy: As owners of pension service business-
es age, many are looking for strategies to realize the
value of their equity and diversify their investments.
Some owners want to preserve the independence
of their firms, transferring ownership to a few key
employees over time. Other owners want to maximize
the value they receive, regardless of the purchaser and
its ultimate plans for the business. Different goals lead
to different transactions, but the ultimate goal remains
similar—retiring from the business.
Remain Competitive: There is constantly increas-
ing pressure on smaller firms when large financial
institutions offer “free” administrative services in
order to capture assets under management. Firms
experiencing dwindling profits and client losses
may seek to combine with other firms offering asset
management or advisory services in order to remain
competitive and boost profitability. These firms may
want to become part of a larger organization that offers
greater marketing and distribution channels, greater
resources for technological expansion, and additional
complementary services.
DIFFERENT WAYS OF STRUCTURING DEALS
ASSET SALE
An asset sale entails the transfer of legal title of assets
from one firm to another. Most, if not all, of the assets
sold will be intangible assets, such as client lists,
2
existing client service contracts, leases, and goodwill.
(Some tangible assets, such as computers, furniture,
and supplies may be included, but these are incidental
to the intangibles that are the reasons for the sale.)
Buyers usually prefer an asset sale because the buyer
acquires only the assets and liabilities that are subject
to the agreement. Undesirable assets and liabilities
remain the seller’s, unless expressly assumed by the
buyer. In this way, a buyer can limit or eliminate
liability for the seller’s conduct (e.g., taxes and
penalties due to mistakes in plan administration).1 Of
course, many aspects of plan administration from a
prior year affect administration in subsequent years,
which can, if not handled carefully by the buyer,
create liability for the buyer. Nonetheless, asset sales
give a buyer greater ability to contain or avoid these
liabilities.
For a seller, asset sales may be less desirable, mainly
because of the typical tax treatment. Usually gain or
loss is recognized upon the sale and, if the seller is a
C corporation, the proceeds may be taxed twice—once
to the corporation and again when received by the
owner. To some extent, allocating some of the price to
an owner’s personal goodwill or a personal restrictive
covenant may mitigate double taxation. Although
double taxation is not an issue for an S corporation or
limited liability company, the gain (or at least some
of it) may be taxed as ordinary income.
STOCK SALE2
A stock sale involves the transfer of ownership of a
business. The seller is the business owner, rather than
the business itself. Business operations remain intact,
subject to the new ownership, and the business retains
whatever obligations and liabilities it previously
held. Acquired liabilities may be “walled-off” in a
separate legal entity, insulating other operating assets
(e.g., owners are not personally liable for corporate
liabilities in most circumstances). Nonetheless,
concern over hi dden liabilities usually makes buyers
less willing to purchase stock.
Despite this, there are many reasons for a buyer to
purchase stock. Buying stock allows the buyer to
obtain not only the business’s operating assets, but
also its existing legal structure and status, including
licenses and contractual relationships (which may
not be assignable in an asset sale).3 Further, key
employees may want to invest in their employer
and take over as the next generation of owners of an
existing, successful business.
From the seller’s perspective, a stock sale may be
more desirable. The tax treatment is likely to be more
favorable, as there would be no double taxation even
for a C corporation and the gain is taxed as capital
gain. Thus, the business owner will realize more
net tax proceeds in a stock sale than in the typical
THE ASPA JOURNAL
JANUARY–FEBRUARY 2004
asset sale. Also, the stock sale eliminates the post-
transaction wind-up of the business, which can absorb
a good deal of time and money. Thus, a stock sale is a
more attractive exit strategy for the business owner.
REORGANIZATIONS
A “reorganization” under the Internal Revenue Code
can take a variety of forms, all of which result in a
tax-free transaction. Most reorganizations involve
a merger of the seller (referred to as “the target”)
into the buyer or a subsidiary. A reorganization can
also take the form of an exchange of assets for stock
(allowing the buyer to leave liabilities behind). Like
all other tax-advantaged structures, a reorganization
is subject to strict requirements under the Internal
Revenue Code. For example, the shareholders of
the target must obtain ownership in the continuing
entity. Because of this requirement (and others),
reorganizations are not always favored, despite the
tax treatment. Thus, a shareholder seeking to diversify
his/her holdings probably will not be willing to
receive stock, particularly if it is stock of a privately
held corporation.4 Similarly, owners of a privately
held corporation may not want to admit minority
shareholders.
On the other hand, where a publicly traded corpora-
tion is making the acquisition (so there is a ready
market, and an established market value for the
stock) or the selling shareholder will continue as
a key employee of the acquirer (thus desiring an
equity-stake in the venture), a reorganization may
satisfy the parties’ goals.
In addition, the credit risk is more complex than
in a stock sale paid in part with a promissory note.
The risk is that the enterprise will not succeed and
that the stock received will not retain or increase
in its value. In the case of a closely held company,
there is also a lack of marketability and potential
minority shareholder issues. Nevertheless, there are
strategies to address these concerns. For example,
a shareholders’ agreement can create a market
for the stock by requiring the corporation to buy
out a shareholder’s interest upon termination of
employment, death, etc. (also important for an S
corporation to avoid having ineligible shareholders),
and by establishing the value of the stock (by a set
formula, by process of appraisal, or by agreement to
a set value).
PRACTICAL CONSIDERATIONS
In any transaction, regardless of motivation or
structure, there are a number of practical issues
and problems that must be addressed. Among the
most crucial and sensitive are: pricing, staffing,
due diligence, and transition. Circumstances are
always dynamic and decisions on one issue often
affect others.
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JANUARY–FEBRUARY 2004
PRICE AND PAYMENT TERMS
Pricing is totally dependent on the circumstances and
should not be agreed to until substantial financial due
diligence is completed. Because the primary assets
purchased are intangible, pricing is usually a function
of revenue or profits, and typically involves a range of
multiples. Higher multiples, though, may be subject to
certain client retention, revenue, and profit levels being
realized. Price need not be a function of revenue—it
can be based on profits traced to the acquired business,
and again, can have limits (e.g., a set percentage over a
set time, with or without an absolute limit). Even after
the price is established, purchase price adjustments
can be used to account for circumstances discovered
during due diligence.
Proper pricing requires careful review of the
seller’s finances (highlighting the importance of a
confidentiality agreement and carefully written letter
of intent) as well as the buyer’s plan for the acquired
business (keep the existing staff and office space and
honor the seller’s fees or consolidate clients at a central
location without hiring staff). Other issues relative to
pricing include payment terms. For instance, a seller
will often accept a lower price if paid in full at closing.
Buyers may insist on spreading payments of a higher
price over time, possibly with periodic adjustments
based on performance. Other issues to consider
include who receives continuing trail payments for
investments and income derived from restatements
and major amendments affecting all plans.
Payment term options must be considered carefully.
Although payment in cash in full at closing will usually
justify a lower price, this approach makes enforcing
an indemnification claim harder since there are no
payments to withhold. Typically, therefore, payment
is in a combination of cash and note. Negotiation
of a note involves many terms, including interest
rate (whether fixed or variable), events of default,
grace periods, remedies, and collateral. Typical
collateral includes a stock pledge (in a stock sale), a
security interest in the buyer’s assets, and personal
guarantees—again, all negotiated. Depending on
the bargaining strength of the parties, collateral
arrangements can also include various restrictions
on the buyer’s conduct, for instance, limiting the
amount of debt it may incur, capital expenditures, and
compensation paid to owners. In all events, these are
individually negotiated and carefully documented.
STAFFING
Buyers need to consider carefully whether existing
staff is sufficient to provide attentive service to
the acquired clients. A buyer also needs to give
much attention to understanding how best to
preserve client relationships—value lies in intact,
strong relationships. Thus, if a buyer needs more
3
 staff to support the new clients, hiring the seller’s
employees has many obvious advantages—the
buyer obtains institutional knowledge about
clients, their expectations, and how the plans were
administered, and client-consultant relationships are
preserved. As a result, the transition as a whole is less
disruptive to clients and other advisors. An added
advantage is that it can greatly speed up and ease the
transition, thus reducing the cost, increasing client
retention, and increasing the long-term value of the
acquired business. On the other hand, new employees
must be compatible with existing culture and be
trained on new systems and procedures. A buyer
intending to hire a seller’s employees should still use
standard hiring practices (i.e., interview each person
and check references). Even if the additional staff is
not needed, a buyer should consider whether to hire
(as an employee or contractor) the seller’s principal
and/or key employees to facilitate the transition,
progressively transfer knowledge, and help integrate
staff.
If the buyer wants to hire the seller’s employees, he or
she should carefully review applicable employment
agreements and consider whether to assume them, or
instead, have the seller terminate the agreements and
establish new terms and conditions of employment.
Consideration should be given in this situation as to
whether, under applicable state law, the buyer could
enforce restrictive covenants (e.g., non-compete
provisions, if the agreements are assumed).5 Similarly,
the seller’s owners should be required to sign
confidentiality, non-solicitation, and non-competition
agreements, whether or not they are hired. Such
agreements should tie-in with payment terms so that
a buyer can suspend payments upon breach, and for
this reason it will often be appropriate, even in an asset
sale, to allocate a portion of the total consideration to
the restrictive covenants.
The importance of all of these staffing issues cannot
be understated. As a service business, a pension
consulting practice’s true assets are the people, their
professional and technical skills, and relationships
built up over time. A buyer may spend a great deal
of time, effort, and money transitioning clients, only
to face high levels of client turnover as clients find
and follow their trusted consultant (often a non-
competition covenant will not prevent a consultant
from accepting a client where the client initiates
contact). Further, inadequate staff leaves new clients
disgruntled and more prone to seek services else-
where. Thus, staffing is one of the most important
issues to address early on in a transaction.
TRANSITION
The transition of business can make or break a
transaction. In an asset sale, the parties have to decide
who will complete work in progress (e.g., testing and
4
annual administration). Typically, there will be a date
on which the seller stops all new work and has until
closing to complete work in progress. Other work a
seller may retain may include completing pending
plan terminations and mergers and plan document
restatements/amendments. Where the seller is shutting
down, arrangements should be made for following up
on completed work and finishing retained work.
Transition of such financial matters as billing also
need careful planning, especially if billing cycles
differ. The parties need to decide when the buyer
will start billing in its name, and in this regard, the
buyer needs to decide if it will continue to abide by
the seller’s fee schedules and billing cycle or change
all clients to its schedules/cycle. (Typically, this
financial transition is done over time.) Also, decisions
must be made regarding billing and payment for any
work the seller completed as of closing and any post-
closing work the seller will finish. Assuming the seller
keeps its receivables, the seller should consider and
discuss with the buyer how the seller intends to collect
these receivables and whether the collection activities
will be disruptive.
Finally, the timing of the announcement to clients
needs careful thought. The proper timing depends on
the structure of the deal—a stock deal or reorganiza-
tion is less disruptive, so clients may tolerate less
advance notice. Similarly, in an asset sale where the
buyer is hiring seller’s employees, advance notice
may be less important. Also, a seller may want
shorter notice to reduce the chance that business will
move simply due to the announcement. Typically,
the announcement is handled through a joint mailing
coupled with telephone calls.
DUE DILIGENCE
Due diligence is the term used to broadly encompass
a review of the seller’s assets, finances, and opera-
tions. In a reorganization, due diligence will be
two-way. In a simple asset sale, due diligence will
focus on the assets being sold. For example, a third
party administrator acquiring an administration
business should review at least a wide sampling
of the administration files, plan documents, and
computer records relating to the client; interview
the responsible consultant; and investigate the fee
structure, billing cycle, revenue, and profitability.
Due diligence becomes more involved where a buyer
will be assuming leases (such as for office space),
licenses, and contracts. In these circumstances, all
relevant documents and laws need to be reviewed to
determine if they can be assigned (in an asset sale) or
will be affected by a change in ownership. In a stock
sale or reorganization, due diligence will include a
review of tax returns and corporate records, including
bylaws, shareholder agreements, minutes, and
corporate standing (compliance with state corporate
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filing requirements), and will be two-way (i.e., the
seller will also conduct due diligence on the buyer.)
Employment-related due diligence in stock sales and
reorganizations should also include a review of the
seller’s benefits and compensation arrangements, as a
result of which decisions will be made as to whether
or not to retain them. (It may be simplest to terminate
all benefit plans before closing, but a buyer may want
to continue existing employment contracts.) The seller
should be required to obtain all third-party consents.
In large transactions, often consultants/accountants
conduct the due diligence. Nonetheless, given the
many legal issues involved and the potential impact
on the overall deal, counsel should be closely involved
as well, particularly where contractual and other legal
issues are involved.
Often due diligence reveals liabilities of which the
seller was unaware (or hoped the buyer would not
discover). These liabilities may not be so severe as
to cause the buyer to abandon the transaction, so
the parties may need strategies for managing these
items in practical and financial terms. Some
approaches include:
(1) requiring corrective action before the closing;
(2) holding sale proceeds in escrow as a reserve
against certain types of claims;
(3) including specific indemnification/hold harmless
provisions in the agreement of sale; and/or
(4) requiring seller to obtain tail insurance to cover
these liabilities.
A BRIEF MENTION OF JOINT VENTURES
Because of the many complexities of a transaction,
parties may decide to conduct a joint venture as an
interim step on the path to a merger or reorganization,
allowing the parties to become comfortable with
each other, test assumed synergies and efficiencies,
and develop joint operational procedures. Careful
planning of who will manage the joint venture,
who will govern the joint venture and how, what
responsibilities the parties have, and how the joint
venture may be unwound are issues of paramount
importance. Without fully discussing these issues and
carefully documenting the agreements, inefficiency
and disputes will be inevitable.
REALITY CHECK
This article addresses many issues that arise in most
transactions and suggests a variety of strategies for
addressing them. Every deal is different and has its
own dynamic depending on objective and subjective
factors, from finances to personalities. The degree
of formality, the extent of due diligence, and the
amount of detail included in the documentation will
vary depending on these dynamics. A transfer of
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administration clients between firms well known
to each other may proceed based on a simple letter
describing price, timing, and identifying clients. By
necessity, a reorganization entails more complex
documentation and due diligence. The formality also
depends on the relationship between the parties—two
local firms may combine based on a short agreement
given the knowledge and trust they have in each other.
Transactions with large institutions will be much more
formal. All of the issues discussed above should be
considered, even in a small deal, and understandings
reached, otherwise expectations are sure to be
frustrated. Experienced counsel is sensitive to these
dynamics and can provide advice and guidance,
anticipate issues, offer pragmatic solutions, and
effectively document the deal so that the business can
move forward with a clear plan of action.
CONCLUSION
It is likely that, as more baby-boomer business
owners retire, the pension service industry will go
through additional consolidation. Developing the
most efficient transaction and shepherding it to a
successful conclusion is a highly fluid process
requiring technical knowledge and practical
experience. Owners should spend time carefully
considering their goals in pursuing a transaction
and thinking through the many practical issues
involved. With careful analysis, time spent on
planning and implementation, and a measure of luck,
transactions can succeed and the difficulties recede
into memory. �
Footnotes
1
Of course, if the seller is shutting down, clients may be left
without recourse, leading clients to look toward the buyer.
Also, if the buyer employs the seller’s employees, clients may
not appreciate the distinction between seller and buyer. Thus, a
buyer may agree to assume some or certain types of liabilities
of the buyer. If so, this should be taken into account in pricing
the deal, through a purchase price adjustment (perhaps if the
buyer’s costs of correction exceed a specified threshold), and/or
through indemnification (coupled with a purchase price escrow
and/or tail insurance).
2
Although the term “stock” is used in this discussion, it would be
more accurate to refer to “equity” sales, to encompass ownership
of non-corporate entities, such as limited liability companies.
3
It is also possible that aspects of an entity’s legal infrastructure
may not be conveyed despite the sale being a de facto assign-
ment of the entity’s ownership (e.g., certain licenses). Again,
careful review of applicable contracts, licenses, and regulations
is essential.
4
Optimal tax treatment and maximum diversification can be
achieved through a “Section 1042 exchange,” in which a C cor-
poration shareholder sells at least 30% of the outstanding stock
to a leveraged ESOP, and reinvests the proceeds tax-free. A full
discussion of Section 1042 exchanges is beyond the scope of
this article but should be considered where an owner is looking
for a tax-advantaged exit strategy.
5
Another concern is the issue of enforcing restrictive covenants
if the buyer does not hire the employee.
5
 Elliot D. Raff, APM, is an attorney with Flaster/Green-
berg PC, a business and commercial law firm in Cherry
Hill, NJ. Elliot is a member of the firm’s Employee
Benefits and Tax and Business Law Practice Groups.
His practice focuses on advising plan sponsors and
benefit consultants in the design, implementation,
and ongoing administration of qualified, non-qualified,
and welfare plans. Elliot has represented businesses,
including pension administration firms, and their
owners, in connection with business acquisitions and
sales. Note: Elliot would like to thank his colleague,
Allen P. Fineberg, APM, also of Flaster/Greenberg PC,
for his assistance in the preparation of this article.

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